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The Effect of Better Information on Income Inequality

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Abstract

We consider an OLG economy with endogenous investment in human capital. Heterogeneity in individual human capital levels is modelled by a distribution of innate ability across agents. This distribution is common knowledge but, at young age, no agent knows his/her ability. The production of human capital depends on each individual’s investment in education. This investment decision is taken only after observing a signal which is correlated to his/her true ability, and which is used for updating beliefs. Thus, a better information system affects the distribution of human capital in each generation. Assuming separable and identical preferences for all individuals, we derive the following results in equilibrium: (a) If the relative measure of risk aversion is less (more) than 1 then more information raises (reduces) income inequality. (b) When a risk sharing market is available better information results in higher inequality regardless of the measure risk aversion.

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Authors and Affiliations

  1. Bielefeld University, 33501, Bielefeld, Germany

    Bernhard Eckwert

  2. The Eitan Berglas School of Economics and CESifo, Tel Aviv University, Tel Aviv, Israel

    Itzhak Zilcha

Authors
  1. Bernhard Eckwert
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  2. Itzhak Zilcha
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Correspondence to Bernhard Eckwert.

Additional information

We are grateful to Alex Cukierman, Zvi Eckstein, Yona Rubinstein and Daniel Tsiddon. An anonymous referee made extremely useful comments and suggestions. Financial support from the German-Israeli Foundation for Scientific Research and Development (GIF) is gratefully acknowledged.

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Eckwert, B., Zilcha, I. The Effect of Better Information on Income Inequality. Economic Theory 32, 287–307 (2007). https://doi.org/10.1007/s00199-006-0120-8

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  • DOI: https://doi.org/10.1007/s00199-006-0120-8

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